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Inflation, Taxation and Capital Cost

Author

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  • Bergström, Villy

    (Research Institute of Industrial Economics (IFN))

  • Södersten, Jan

    (Research Institute of Industrial Economics (IFN))

Abstract

In times of inflation, most existing systems of taxation introduce new distortions into the allocation of resources. In this paper, the effects of inflation via taxes on the firm's east of capital are analyzed. The taxes considered are the corporate income tax and household taxes on dividends and capital gains. The first part of the paper presents the model of a firm aiming at maximizing the value of its shares in the portfolios of the stockholders. The nominal east of capital of this firm, financed by equity and debt in a given proportion, is derived. The east of equity and debt are then taken at their nominal values as the firm observes them on the capital market. We then analyze the net real cost of capital, where market rates of return are adjusted for inflation. This makes it possible to determine the net effects of inflation on capital cost, recognizing several counteracting tendencies operating through the tax system. It turns out that for most reasonable assumptions, the real cost of capital will fall as a result of inflation when both profit tax and taxes on dividends and capital gains are taken into account. In the last section finally, we present different ways of indexing the system of taxation to insulate it from inflationary distortions.

Suggested Citation

  • Bergström, Villy & Södersten, Jan, 1979. "Inflation, Taxation and Capital Cost," Working Paper Series 19, Research Institute of Industrial Economics.
    • Handle: RePEc:hhs:iuiwop:0019
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    References listed on IDEAS

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    1. Paul A. Samuelson, 1964. "Tax Deductibility of Economic Depreciation to Insure Invariant Valuations," Journal of Political Economy, University of Chicago Press, vol. 72(6), pages 604-604.
    2. Martin Feldstein & Lawrence Summers, 1983. "Inflation, Tax Rules, and the Long-term Interest Rate," NBER Chapters, in: Inflation, Tax Rules, and Capital Formation, pages 153-185, National Bureau of Economic Research, Inc.
    3. Martin Feldstein & Jerry Green & Eytan Sheshinski, 1983. "Inflation and Taxes in a Growing Economy with Debt and Equity Finance," NBER Chapters, in: Inflation, Tax Rules, and Capital Formation, pages 44-60, National Bureau of Economic Research, Inc.
    4. Martin Feldstein, 1983. "Inflation, Income Taxes, and the Rate of Interest: A Theoretical Analysis," NBER Chapters, in: Inflation, Tax Rules, and Capital Formation, pages 28-43, National Bureau of Economic Research, Inc.
    5. Aaron, Henry J, 1976. "Inflation and the Income Tax," American Economic Review, American Economic Association, vol. 66(2), pages 193-199, May.
    6. Siebert, Calvin D. & Jorgenson, Dale W., 1968. "Optimal Capital Accumulation and Corporate Investment Behavior," Scholarly Articles 3403057, Harvard University Department of Economics.
    7. Nelson, Charles R, 1976. "Inflation and Capital Budgeting," Journal of Finance, American Finance Association, vol. 31(3), pages 923-931, June.
    8. Sandmo, Agnar, 1974. "Investment Incentives and the Corporate Income Tax," Journal of Political Economy, University of Chicago Press, vol. 82(2), pages 287-302, Part I, M.
    9. Appelbaum, Elie & Harris, Richard G, 1978. "Optimal Capital Policy with Bounded Investment Plans," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 19(1), pages 103-114, February.
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    Cited by:

    1. Hovick Shahnazarian, 2009. "Does Tax Debt Capacity Matttter?," Finnish Economic Papers, Finnish Economic Association, vol. 22(1), pages 21-30, Spring.

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    More about this item

    Keywords

    Inflation; Taxation; Stock;
    All these keywords.

    JEL classification:

    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • H21 - Public Economics - - Taxation, Subsidies, and Revenue - - - Efficiency; Optimal Taxation
    • O16 - Economic Development, Innovation, Technological Change, and Growth - - Economic Development - - - Financial Markets; Saving and Capital Investment; Corporate Finance and Governance

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